GRAIN BROKERS
Characteristics of an
optimal hedging strategy
In the previous two editions we focused on the factors which will influence a producer’s
hedging decision, as well as the issue of market efficiency. The conclusion of the said
articles was that the JSE agri-product market is generally liquid and, as indicated by
specific research, it responds sufficiently to new information. This implies that the
market offers an effective platform to role players to apply price management. Building
in this premise, this article will focus on the applicable research with respect to different
hedging strategies.
By Frans Dreyer
Manager: Senwes Grain Brokerage
T
he term hedging strategy relates
to the strategy or marketing plan
which a producer can follow in
order to determine or protect the
value of production by means of derivative
instruments. Hedging as such remains one
of the more difficult decisions which pro-
ducers are confronted with every season.
A producer has to be satisfied with the
reality that hedging decisions in respect of
a crop, which may still have to be planted
and which usually still has to be harvested,
are taken on the basis of the information
available at the specific time. This real-
ity means that the implementation of a
hedging strategy, rather than a haphazard
hedging decision, is a less risky approach.
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SENWES SCENARIO | SPRING 2018
As a result, hedging strategies are
researched on a regular basis to determine
the type of strategy which will render the
best results over time. International hedg-
ing strategy research could not reach con-
sensus on an optimal strategy, but certain
characteristics of an optimal hedging strat-
egy were identified. These characteristics
will be referred to throughout this article.
The development of hedging strategies
within the South African market context is
also based on international research.
The first important research in this
regard was done shortly after deregulation
by Grönum and Van Schalkwyk (2000).
Their results related to the specific optimal
characteristic that a strategy has to be
sufficiently adaptable in order to be able to
absorb or accommodate unforeseen price
reactions as a result of production risks
within the strategy. An important aspect
which was highlighted, was that a strategy
has to address price and income risk by
taking the cost of production into account.
A marketing decision must therefore be
based on profitability.
Further research by Scheepers (2005)
was of the first studies in which three
different strategies were compared with
the alternative of not hedging at all and of
selling after harvest time. The first strategy
was to hedge total production during the
planting period by selling term contracts
against the following July contract. The
second strategy developed from the foun-
dation of the first one and included the
buying of a call-option with the short-term
contract (synthetic put-option). The third
strategy followed the same principle, but
the call-option was bought against the
March contract and not the July contract.
The call-option was specifically bought
against the March contract in order to
decrease option costs and to test the the-